WRITTEN BY INVESTMENT STRATEGIST AND PORTFOLIO MANAGER, HAROLD STRYDOM
Scenario modelling has formed part of Peregrine Wealth’s investment philosophy for two decades, and it enables us to better understand potential market outcomes and construct stronger portfolios. The Peregrine Wealth Investment team has a core, or “High Conviction” scenario based on a three-year view, which is expressed as macro-economic and market assumptions, including economic growth, inflation, interest rates, price-earnings (PE) multiples, and credit spreads, to list a few. Based on these assumptions, our asset valuation models produce expected returns for various asset classes. This section is used to summarise our High Conviction view and the resulting asset signals.
Central banks have rapidly hiked interest rates into restrictive territory to bring inflation under control. Inflationary pressures are easing, and we are approaching the end of the rate hiking cycle. Global economic growth is weakening, and recessionary indicators are flashing red. The extent of the economic downturn in 2023/24 remains highly uncertain. As such, when it comes to investing, we are considering a range of potential economic outcomes, with multiple scenarios feeding into our asset allocation process.
Our High Conviction scenario assumes that global economic growth will be below capacity over the next two years, with weak growth across developed markets, including the United Kingdom (UK). However, emerging markets will experience better growth due to China’s expected rebound. Below capacity growth and slowing inflation translates into weak company earnings growth. Our projected earnings growth numbers are below consensus, which have remained strong. Valuations (trailing PE ratios) are reasonably attractive compared to long-term historical averages but are not compensating for the risk to earnings. Global equities are rated neutral, but most other developed markets’ expected returns are rated below neutral and emerging markets (EM) are rated above neutral.
United States (US) and UK fixed income is rated neutral overall. Enhanced cash is attractive given the rate hikes. Bond yields are above our assumed exit yields. Investment grade credit spreads are above long-term fair value assumptions, but spreads can widen further as company earnings come under pressure.
The investment horizon is crucial. Reduced liquidity and increased recession risk are likely to continue, causing weakness and volatility across markets in the near-term. See the table below for a summary of our Asset Class Valuation Signals based on three-year High Conviction scenario.